Savings Bond Alert #028
Monday, March 19th, 2007
Categorized as: Savings Bond Alerts
Next I Bond inflation component likely to be low
The level of February’s Consumer Price Index finally rose above September’s level, according to the Bureau of Labor Statistics. The difference between the March and September levels will determine the next Series I Savings Bond inflation component, which is likely to be relatively low – probably in the 1% to 2% range.
Meanwhile, the stock market has become much more volatile, with wild swings up and down of 1 per cent or more almost daily since the large drop on Feb 27. As money moves out of stocks and into bonds, bond prices go up and bond interest rates go down.
This is not good news for the I bond fixed-base rate. Based on where rates for Treasury Inflation Protected Securites (TIPS) are right now, the Treasury is more likely to lower the I Bond fixed base-rate than to raise it, although we’ll have a better idea of this a month from now.
The low Savings Bond rates since last May have taken their toll on new investments in Savings Bonds, which are running about 50% lower than a year ago and are at historically low levels.
This is because Savings Bond rates are tied to long-term interest rates, which have been lower than short-term rates. This unusual situation, which is called an inverted yield curve, is a potent predictor of an upcoming recession.
The inverted yield curve also means that short-term investments, such as one-year bank CDs, offer much higher rates than Savings Bonds. And that’s why new investments in Savings Bonds are currently so low.
The stock market volatility has been blamed on a meltdown in the subprime mortage market. Through incompetence or outright fraud over the last two to three years, home lenders have obtained financing for billions of dollars worth of mortgages they gave to people who have no hope of repaying them.
This fueled the housing price bubble. Now these mortgages are starting to go into foreclosure and the lending companies are making it much harder to get a mortgage. With mortgages harder to get and foreclosed homes coming on the market, the price of homes is falling.
It’s important to note, however, that the housing component of the CPI is based on rental prices, not on home prices. The large movement of subprime borrowers into homes actually held the CPI down by putting pressure on rental prices.
Now that people are staying in and moving back into rental units, rental prices are set to go up and take the CPI with them. I bond investors will earn more interest as a result – probably starting next fall.